Why Socialism Failed
Published in Ideas on Liberty - June 1995
by Mark J. Perry
Socialism is the Big Lie of the twentieth century. While it promised prosperity,
equality, and security, it delivered poverty, misery, and tyranny. Equality
was achieved only in the sense that everyone was equal in his or her misery.
In the same way that a Ponzi scheme or chain letter initially succeeds but
eventually collapses, socialism may show early signs of success. But any accomplishments
quickly fade as the fundamental deficiencies of central planning emerge.
It is the initial illusion of success that gives government intervention its
pernicious, seductive appeal. In the long run, socialism has always proven
to be a formula for tyranny and misery.
A pyramid scheme is ultimately unsustainable because it is based on faulty
principles. Likewise, collectivism is unsustainable in the long run because
it is a flawed theory. Socialism does not work because it is not consistent
with fundamental principles of human behavior. The failure of socialism in
countries around the world can be traced to one critical defect: it is a system
that ignores incentives.
In a capitalist economy, incentives are of the utmost importance. Market
prices, the profit-and-loss system of accounting, and private property rights
provide an efficient, interrelated system of incentives to guide and direct
economic behavior. Capitalism is based on the theory that incentives matter!
Under socialism, incentives either play a minimal role or are ignored totally.
A centrally planned economy without market prices or profits, where property
is owned by the state, is a system without an effective incentive mechanism
to direct economic activity. By failing to emphasize incentives, socialism
is a theory inconsistent with human nature and is therefore doomed to fail.
Socialism is based on the theory that incentives don't matter!
In a radio debate several months ago with a Marxist professor from the University
of Minnesota, I pointed out the obvious failures of socialism around the world
in Cuba, Eastern Europe, and China. At the time of our debate, Haitian refugees
were risking their lives trying to get to Florida in homemade boats. Why
was it, I asked him, that people were fleeing Haiti and traveling almost 500
miles by ocean to get to the "evil capitalist empire" when they were only
50 miles from the "workers' paradise" of Cuba?
The Marxist admitted that many "socialist" countries around the world were
failing. However, according to him, the reason for failure is not that socialism
is deficient, but that the socialist economies are not practicing "pure" socialism.
The perfect version of socialism would work; it is just the imperfect socialism
that doesn't work. Marxists like to compare a theoretically perfect version
of socialism with practical, imperfect capitalism which allows them to claim
that socialism is superior to capitalism.
If perfection really were an available option, the choice of economic and
political systems would be irrelevant. In a world with perfect beings and
infinite abundance, any economic or political system--socialism, capitalism,
fascism, or communism--would work perfectly.
However, the choice of economic and political institutions is crucial in
an imperfect universe with imperfect beings and limited resources. In a world
of scarcity it is essential for an economic system to be based on a clear
incentive structure to promote economic efficiency. The real choice we face
is between imperfect capitalism and imperfect socialism. Given that choice,
the evidence of history overwhelmingly favors capitalism as the greatest wealth-producing
economic system available.
The strength of capitalism can be attributed to an incentive structure based
upon the three Ps: (1) prices determined by market forces, (2) a profit-and-loss
system of accounting and (3) private property rights. The failure of socialism
can be traced to its neglect of these three incentive-enhancing components.
The price system in a market economy guides economic activity so flawlessly
that most people don't appreciate its importance. Market prices transmit information
about relative scarcity and then efficiently coordinate economic activity.
The economic content of prices provides incentives that promote economic
For example, when the OPEC cartel restricted the supply of oil in the 1970s,
oil prices rose dramatically. The higher prices for oil and gasoline transmitted
valuable information to both buyers and sellers. Consumers received a strong,
clear message about the scarcity of oil by the higher prices at the pump and
were forced to change their behavior dramatically. People reacted to the
scarcity by driving less, carpooling more, taking public transportation, and
buying smaller cars. Producers reacted to the higher price by increasing their
efforts at exploration for more oil. In addition, higher oil prices gave
producers an incentive to explore and develop alternative fuel and energy
The information transmitted by higher oil prices provided the appropriate
incentive structure to both buyers and sellers. Buyers increased their effort
to conserve a now more precious resource and sellers increased their effort
to find more of this now scarcer resource.
The only alternative to a market price is a controlled or fixed price which
always transmits misleading information about relative scarcity. Inappropriate
behavior results from a controlled price because false information has been
transmitted by an artificial, non-market price.
Look at what happened during the 1970s when U.S. gas prices were controlled.
Long lines developed at service stations all over the country because the
price for gasoline was kept artificially low by government fiat. The full
impact of scarcity was not accurately conveyed. As Milton Friedman pointed
out at the time, we could have eliminated the lines at the pump in one day
by allowing the price to rise to clear the market.
From our experience with price controls on gasoline and the long lines at
the pump and general inconvenience, we get an insight into what happens under
socialism where every price in the economy is controlled. The collapse of
socialism is due in part to the chaos and inefficiency that result from artificial
prices. The information content of a controlled price is always distorted.
This in turn distorts the incentives mechanism of prices under socialism.
Administered prices are always either too high or too low, which then creates
constant shortages and surpluses. Market prices are the only way to transmit
information that will create the incentives to ensure economic efficiency.
Profits and Losses
Socialism also collapsed because of its failure to operate under a competitive,
profit-and-loss system of accounting. A profit system is an effective monitoring
mechanism which continually evaluates the economic performance of every business
enterprise. The firms that are the most efficient and most successful at serving
the public interest are rewarded with profits. Firms that operate inefficiently
and fail to serve the public interest are penalized with losses.
By rewarding success and penalizing failure, the profit system provides
a strong disciplinary mechanism which continually redirects resources away
from weak, failing, and inefficient firms toward those firms which are the
most efficient and successful at serving the public. A competitive profit
system ensures a constant reoptimization of resources and moves the economy
toward greater levels of efficiency. Unsuccessful firms cannot escape the
strong discipline of the marketplace under a profit/loss system. Competition
forces companies to serve the public interest or suffer the consequences.
Under central planning, there is no profit-and-loss system of accounting
to accurately measure the success or failure of various programs. Without
profits, there is no way to discipline firms that fail to serve the public
interest and no way to reward firms that do. There is no efficient way to
determine which programs should be expanded and which ones should be contracted
Without competition, centrally planned economies do not have an effective
incentive structure to coordinate economic activity. Without incentives the
results are a spiraling cycle of poverty and misery. Instead of continually
reallocating resources towards greater efficiency, socialism falls into a
vortex of inefficiency and failure.
Private Property Rights
A third fatal defect of socialism is its blatant disregard for the role
of private property rights in creating incentives that foster economic growth
and development. The failure of socialism around the world is a "tragedy of
commons" on a global scale.
The "tragedy of the commons" refers to the British experience of the sixteenth
century when certain grazing lands were communally owned by villages and were
made available for public use. The land was quickly overgrazed and eventually
became worthless as villagers exploited the communally owned resource.
When assets are publicly owned, there are no incentives in place to encourage
wise stewardship. While private property creates incentives for conservation
and the responsible use of property, public property encourages irresponsibility
and waste. If everyone owns an asset, people act as if no one owns it. And
when no one owns it, no one really takes care of it. Public ownership encourages
neglect and mismanagement.
Since socialism, by definition, is a system marked by the "common ownership
of the means of production," the failure of socialism is a "tragedy of the
commons" on a national scale. Much of the economic stagnation of socialism
can be traced to the failure to establish and promote private property rights.
As Peruvian economist Hernando de Soto remarked, you can travel in rural
communities around the world and you will hear dogs barking, because even
dogs understand property rights. It is only statist governments that have
failed to understand property rights. Socialist countries are just now starting
to recognize the importance of private property as they privatize assets and
property in Eastern Europe.
Without the incentives of market prices, profit-and-loss accounting, and
well-defined property rights, socialist economies stagnate and wither. The
economic atrophy that occurs under socialism is a direct consequence of its
neglect of economic incentives.
No bounty of natural resources can ever compensate a country for its lack
of an efficient system of incentives. Russia, for example, is one of the world's
wealthiest countries in terms of natural resources; it has some of the world's
largest reserves of oil, natural gas, diamonds, and gold. Its valuable farm
land, lakes, rivers, and streams stretch across a land area that encompasses
11 time zones. Yet Russia remains poor. Natural resources are helpful, but
the ultimate resources of any country are the unlimited resources of its
By their failure to foster, promote, and nurture the potential of their
people through incentive-enhancing institutions, centrally planned economies
deprive the human spirit of full development. Socialism fails because it
kills and destroys the human spirit--just ask the people leaving Cuba in
homemade rafts and boats.
As the former centrally planned economies move toward free markets, capitalism,
and democracy, they look to the United States for guidance and support during
the transition. With an unparalleled 250-year tradition of open markets and
limited government, the United States is uniquely qualified to be the guiding
light in the worldwide transition to freedom and liberty.
We have an obligation to continue to provide a framework of free markets
and democracy for the global transition to freedom. Our responsibility to
the rest of the world is to continue to fight the seductiveness of statism
around the world and here at home. The seductive nature of statism continues
to tempt and lure us into the Barmecidal illusion that the government can
The temptress of socialism is constantly luring us with the offer: "give
up a little of your freedom and I will give you a little more security." As
the experience of this century has demonstrated, the bargain is tempting but
never pays off. We end up losing both our freedom and our security.
Programs like socialized medicine, welfare, social security, and minimum
wage laws will continue to entice us because on the surface they appear to
be expedient and beneficial. Those programs, like all socialist programs,
will fail in the long run regardless of initial appearances. These programs
are part of the Big Lie of socialism because they ignore the important role
Socialism will remain a constant temptation. We must be vigilant in our
fight against socialism not only around the globe but also here in the United
The failure of socialism inspired a worldwide renaissance of freedom and
liberty. For the first time in the history of the world, the day is coming
very soon when a majority of the people in the world will live in free societies
or societies rapidly moving towards freedom.
Capitalism will play a major role in the global revival of liberty and prosperity
because it nurtures the human spirit, inspires human creativity, and promotes
the spirit of enterprise. By providing a powerful system of incentives that
promote thrift, hard work, and efficiency, capitalism creates wealth.
The main difference between capitalism and socialism is this: Capitalism